The city was placed under curfew on Thursday to quell violence that saw mobs rampaging with swords, rocks and other weapons, leaving one Buddhist and one Muslim dead.

It was the latest in a string of deadly religious clashes that have plagued the former junta-run nation for two years, prompting warnings that the country's fragile transition to democracy could be in trouble.

Violence broke out on Tuesday after an accusation spread on the internet that a Buddhist woman had been raped by two Muslim men from a tea shop. A crowd of hundreds gathered near the business, hurling stones and abuse.

"The violence happened because of hate speech and misinformation spread online," an official from the president's office said.

He said the situation was under control but the government had no plan to tackle inflammatory remarks posted on the internet.

Friends and relatives of the Buddhist man killed on Wednesday, a 36-year-old father of three, expressed their shock at the killing as they prepared to hold his funeral.

"He was like a brother to me," said Htwe, who was with the dead man on the night of the attack.

He showed injuries on his hand that he said were slash marks from a "sword" used by a group of Muslims to kill his friend. "I will hold a grudge for the rest of my life," he said.

A funeral for the dead Muslim man, a bicycle shop owner, was held on Thursday, hours after he was killed while on his way to attend early morning prayers.

Kari Hasan, the head of nearby Shaeshaung mosque, said the Muslim community had become a target of hate speech and had been let down by the authorities.

"If something happens they suddenly say it is because of Islam. With the new government we expected good things but we only get bad things," he said.

Sectarian clashes have left at least 250 people dead and tens of thousands displaced since fighting first broke out in Rakhine state in 2012.

Most of the victims of the violence have been Muslim and clashes have often erupted in response to false rumours or individual criminal acts.

Radical Buddhist monks have been accused of stoking religious tensions, while the security forces have been accused of failing to prevent attacks.

Opposition leader Aung San Suu Kyi blamed the authorities for the worsening violence and warned of the dangers of unsubstantiated reports.

"The authorities should properly handle those people who are spreading rumours. Without rule of law, more riots will come," she told Radio Free Asia, according to remarks posted on the broadcaster's website.